August 28, 2014
Presented By
Stephen Thau, Partner

Valuation Truths
• Valuations are:
 More art than science
 What the market says your company is worth
 What a disinterested investor is willing to pay
• Not: Family member, existing equity holder, corporate investor
2

Valuation Terminology
• Valuation: value of equity interests
 Fully diluted: include all shares that could be issued, but not all authorized
• Pre-money: value of equity before financing
 fully diluted shares x price per share
• Post-money: value of equity after financing
 fully diluted shares x price per share
• Post-money – Pre-money = amount raised
3

Valuation Terminology
• Valuation of all equity interests
• Not accounting valuation
• Not 409A valuation
• Not control premium
• Not minority investment
• Not enterprise value
4

Startup Valuation Truths
• Investment decisions are driven only by projected returns on the investor’s investment
• Negotiation, with no correct answer
• Other terms matter too (option pool, preferences, voting rights, etc.)
5

Valuation Not Only Determinant of Founder Value
• Option Pool Investors Investors
Founders Founders
Option Pool
$1M @ $3M Pre
25% Option Pool (post)
Founder Value = $2M
$1M @ $3M Pre
5% Option Pool (post)
Founder Value = $2.8M
• Liquidation Preference
 Non-Participating
 Participating
 Participating with cap
• Dividend Rights (cumulative vs. non-cumulative)
• Antidilution Protection
Option Pool
6

How Much Do You Need to Raise?
• How much money you need to show significant growth or achieve next value-enhancing milestone
• How much of the company do you SELL (not give) to the investor
7

Rule of Thumb: Raise to Value Enhancing Milestone +
• Early stage investors are looking for rapid growth
• e.g., 10X growth in 18 months
• Valuation is responsive to milestone achievement
• Prototype completion
• Product launch
• First 1M users
• etc.
• Things always take longer and cost more than anticipated
• Budget past milestones for runway to raise next round
8

Investor’s Perspective
• Where and when is the exit?
• How much can this company sell for?
• How much total money will it take to grow the company to the point that someone will buy it for…..let’s say, $1 billion?
• What percentage will the investor need to get the return (ROI) desired? 10x? 20x? 50x?
• Desired IRR? (Internal Rate of Return) >25%
(per annum)
9

Market Considerations
• Entrepreneur Valuation Expectations*
 Too Low 9%
 Appropriate 22%
 Too high 69%
• All markets are affected by national trends
• Follow-on investors are not always local
• Entrepreneurs have limited experience of valuation
*According to Angel Resources Institute
10

Angel Group Valuation Survey
• National Survey of Angel Group Investment
Activity – Q1 2014
 Pre-money valuations: $2.7 million
 Mean Round Size: $1.23 million
 Median Round Size: $980K
 Mean Round Size (w/co-investors): $2.43 million
 Median Round Size (w/co-investors): $1.65 million
Source: Halo Report – SVB, Angel Resource Institute, CB Insights
11

Angel Group Valuation Survey
• By Verticals
 Median for Healthcare deals: $1.21 million
 Median for Internet deals: $1.85 million
 Median for Mobile/Telecom deals: $1.0 million
 Healthcare, Internet & Mobile/Telecom comprised 71.4% of deals
Source: Halo Report – SVB, Angel Resource Institute, CB Insights
12

Typical Expected Rates of Return
13

Useful Estimation Methods
• Comparable Transactions
• Comparable Companies
• Venture Capital Method
• Double Revenues Method
• Scorecard Method
• Risk Factors Method
14

Comparable Transactions
• Theory: compare valuation to similarly situated companies raising capital at similar stages
• Reality
 Real data hard to come by
 Anecdotes hard to defend
 Investors can easily find distinguishing features
15

Comparable Companies
• Theory: compare valuations of similar companies when they were at similar stage of development
• Reality:
 More data may be available (recently public companies report 3-5 years of historical results)
 Perceived selection bias (not everyone will be next Google)
 Prepare to defend assumptions re growth
16

Venture Capital Method
=
(valuation at Exit)
(Valuation at Investment or
Pre-money plus investment)
Assuming no dilution
17

Terminal Value
18

Estimating Terminal Value
th
Reminder: Terminal Value = Revenue x Earnings x P/E Ratio
19

Venture Capital Method Made Easy
• Determine the potential value of company at exit
(“terminal value”): i.e., $150MM
• Determine the return on investment required: i.e., 20X
• Calculate Post-Money: $150MM/20 = $7.5MM
• Determine size of investment: i.e., $3MM
• Calculate Pre-Money: $7.5MM- $3MM= $4.5MM
20

Venture Capital Method – Working Backwards From Exit
• Estimate terminal value
• Project all financing rounds to exit
• Build in valuation step-ups for each round
• Work backward to determine initial pre-money
21

Venture Capital Method – Working Backwards From Exit
5x Step-Up to
Exit
3x Step-Up from
Post-A to Pre-B
Assume: $100M exit and $10M capital raise, with $2M
Series A and $8M
Series B
$8M Series B – 5x Return to Exit
 Post-Money = $20M
 Pre-Money = $12M
$2M Series A – 3x Step-Up from
A →B
 Post-Money = $4M
 Pre-Money = $2M
22

Scorecard Method
• Determine median value for pre-revenue companies in your space in your region (recent deals)
• Assign % weighting on each critical issue
• Calculate the weighted average of each issue
• Multiply median value by weighted average
23

• Management
• Size of Opportunity
• Products /Services
• Marketing/Sales
• Competition
Valuation Factors
30%
25%
15%
10%
10%
24

Calculate Weighted Average Multiple
FACTOR ANALYSIS
Management On board except sales
Opportunity Large
Product Disruptive
Sales No channels
Competition No big layers
Other Need partners
WEIGHT RESULT INPUT
30% 120% 36%
25% 130% 33%
15% 130% 20%
10% 50% 5%
10% 110% 11%
10% 80% 8%
Weighted Average 112%
25

Calculate Pre-Money Valuation
26

Risk Factor Method
• Determine a starting valuation point
• Consider and assess risk
• Assign positive or negative values to each
• Pre-money valuation = Sum
27

• Management
• Stage of Business
• Legislative/Political Risk
• Manufacturing Risk
• Sales & Marketing Risk
• Funding/Raising Capital Risk
• Competition
• Technology Risks
• Litigation Risks
• International Risk
• Reputational Risk
• Potential Lucrative Exit
Risk Types
28

Assign Values to Each Risk
• Maximum/Minimum = +3/-3
• i.e., “Stage of Business Risk”
 0 for pre-revenue
 +1 for beta
 +3 for paying customers
• +1= $100k added to pre-money valuation
• -3 = $-300k subtracted from pre-money
29

Management
Stage of Business
Legislative/Political Risk
Manufacturing Risk
Sales & Marketing Risk
Funding/Raising Capital Risk
Competition
Technology Risks
Litigation Risks
International Risk
Reputational Risk
Potential Lucrative Exit
-3
-1
+1
+2
+1
0
-1
+2
0
+1
0
+1
Example
30

Base Valuation
Total value of plusses (8)
Total value of minuses (5)
Pre-Money Valuation
Risk Factor Summary Example
$2,000,000
+ $800,000
- $500,000
$2,300,000
31

Concluding Truths
• Returns drive investment decision
• Calculations generally did not included dilution events such as the impact of subsequent investments
• Valuation is an art not a science
• More important to calculate it rationally and not emotionally
• Use multiple methods
• Estimated valuations are fine to get the conversation started
32

PARTNER
PALO ALTO/WASHINGTON D.C.
(202) 887-1571
STHAU@MOFO.COM
Stephen Thau has been representing emerging companies for close to twenty years. His practice focuses on the representation of technology, life science and medical device companies in transactional matters, including public and private financings, mergers and acquisitions, licensing and collaborations and strategic alliances. He also represents venture capital and investment banking firms in public and private financing transactions. He has represented companies in numerous public offerings, public and private M&A transactions, and collaboration agreements, and companies and investors in over 100 venture capital and debt financing transactions.
Mr. Thau is a frequent speaker on venture capital financings and served on the faculty at the
2005 and 2007 Emerging Entrepreneurs workshops at Stanford University. Mr. Thau is recommended as a leading lawyer by Chambers USA 2014, Legal 500 US 2014 and Best
Lawyers in America 2012. He was also named to the Daily Journal's inaugural list of 25 leading biotech lawyers in California, in 2011.
Rankings
He is ranked in Chambers USA 2014, Legal 500 US 2013-2014 and Best Lawyers in America
2012.
Education
Harvard University (A.B., magna cum laude, 1989)
Stanford University (J.D., Order of the Coif, 1994)
33